STO vs ICO: Which Funding Model Will Prevail?

Alex Momot

One way in which cryptocurrency is already changing the world is as a source of funds for raising capital. Token offerings have democratized startup funding, wrestling the sector from the grip of the super-elite and wealthy, and placing it firmly in the hands of the people.

For that alone, blockchain technology has already proved itself a great leveler of the field, a means of lowering barriers and democratizing industry.

There is a divide at the heart of the market however, and that schism lies between utility and security token models.

(A quick reminder: security tokens are essentially shares, tradable financial assets that entitle their owner to a financial return on profits, while utility tokens have utility value as a means of payment, or some other use case, on the company platform.)

Recently, the wind of popular opinion has been blowing in favor of security tokens. A deluge of articles from various outlets have declared security tokens the future of crypto and predicted the demise of the utility token.

However, for those willing to examine all of the evidence, and for those who have been involved in the sector long enough to remember why ICOs were so revolutionary in the first place, the jury remains out.

The Rise and Stumble of ICOs

When Mastercoin launched that first — initial if you will — Initial Coin Offering in 2013 it also created a bold new funding mechanism which seemed to circumvent traditional markets and regulation. With $500,000 raised, the experiment proved hugely successful, and a trickle of new blockchain projects began to follow suit.

By 2016, that trickle was a torrent, continuing through 2017 to the first quarter of 2018, in which we saw $6.3 billion raised in the first three months alone — although this figure includes unverifiable figures from tokens such as the petro, it should be noted.

Some of the astronomical success in early 2018 we can certainly place at the feet of cryptocurrency reaching an all-time high in Dec 2017, but even without such exceptional circumstances growth had been incredibly strong.

One of the main factors in the success of ICOs was that they were unhindered by regulatory bodies such as the SEC. Under free market conditions the free market flourished, and the dream of a regulated STO market floundered.

In 2018, however, the market moved from bull to bear, and with that, many ideas surrounding regulation were challenged.

A number of high profile cases of the SEC exercising its authority the previous year helped put fear into the market.

Munchee, which the SEC shut down, was one such example. The best known example however was Tezos, who successfully raised $232 million but quickly became embroiled in the Homer’s Iliad of ICO legal disputes.

For those who were concerned by these developments, a seemingly simple and elegant solution lay in waiting. Could the time of the STO have arrived at last?

Enter the STO

In many ways, a Security Token Offering appears an ingenious solution, offering many of the benefits of an ICO without any of the drawbacks. However, inviting the regulator for dinner is a decision to take with care.

Conducting an STO incurs serious upfront legal expenses in the hundreds of thousands, if not millions of dollars. What’s more, the regulators asked to preside over your token issuance are the very same whose world was recently turned upside down by blockchain.

That is not to say they will act with malice towards your filing, but having been stung by the cryptocurrency industry once, they are now likely to take their time examining every aspect with a very deliberate and special care.

To date, the SEC has not approved a single Reg A+ STO, and Reg D only allows for institutional investors to participate. In a single stroke, that cuts out all of the ordinary people who make crypto such an exciting place to be.

Next Big Thing After Next?

2018 ended with a market drop and a radical downtrend in ICOs. In October 2018 there were only 213 new ICO-listings, the lowest figure since the beginning of the year.

As a result, the market has started to look for new ways of attracting investments and turned its attention to the STO-model. But, are we sure this new model of crypto-fundraising is bound to become the white knight of the blockchain space?

All the problems that are true of ICOs are also true of STOs, but in most cases more so. Some ICOs have fallen foul of regulations, while STOs invite regulators to create issues for them.

With all things considered, spending some time designing an elegant utility token seems a much easier path to follow, especially if you conduct your ICO out of a friendly jurisdiction.

For that reason alone, a security token issuance is the tougher and more expensive choice initially. It is a long and complex process, and in an industry which moves as fast as blockchain, six months or more of inaction may feel like years. It is rolling the dice on first mover status.

That said, the book is not closed on security tokens, and nor should it be.

Security tokens have significant potential, but it will take movement from regulators willing to speed up the application process, as well as development of regulated exchanges where the tokens can be traded.

So although security tokens may not be the next big thing, they could be the next big thing after that. Until then, utility tokens are hard to look beyond.

Rather than that, companies need to understand that it is important to build relevant products, based on market requirements and real use-cases. The further we go, the more attention potential investors will pay to the actual value brought up by the idea, not to the way teams try raising funds for its execution.

Boasting over ten years’ IT experience, Alex has been working in the blockchain space since 2013. In 2014 he ran BitX, a start-up that allowed people to pay for telecom and other everyday services in bitcoin. Alex has been a board member of the Bitcoin Foundation Ukraine for the last three years and has also been in bitcoin mining since 2015. Currently, he is the Co-Founder and CEO of Remme, that is working on a distributed Public Key Infrastructure protocol and PKI-enabled apps for the modern web.